Proposed Regulations Issued on Pass-through Tax Deductions

On August 8th, the Internal Revenue Service issued long-awaited proposed regulations for business owners who have been wondering if (and how) the new pass-through tax deduction would apply to them. Although the regulations are not yet final, they do provide further clarification on where their ultimate definitions and parameters will be set.

As we know, all taxpayers with adjusted gross income (AGI) less than $157,500, or $315,000 for a married couple, may now deduct 20 percent of the income they receive via pass-through businesses (including Schedule C) from their overall taxable income. If taxpayers have AGI above those thresholds and are not specified service trade or businesses (SSTB), they may still qualify but must meet certain tests to determine the amount of deduction available.  The deduction then depends on how much was paid in employee wages or how much is invested in qualified property. For SSTB, the deduction fully phases out at AGI of more than $207,500 (single)/$415,000 (married).

Highlights of the proposed regulations are as follows:

  • Some answers are provided regarding the definition of a SSTB, but questions still remain, since the law is vague; there are still thousands of businesses wondering if they qualify.
  • Business owners, including service providers, whose annual gross receipts are less than $25 million a year — with less than 10 percent of that income derived from the service part of their business — will not be subject to the income caps.
  • Within the category of SSTB, there are various classifications. One such classification excludes a business whose principal asset is the reputation or skill of one or more owners or employees.  The proposed regulations provide a more specific definition and examples of the “reputation or skill of one or more employees or owners.”
  • It outlaws a strategy known as “crack and pack,” where business owners split their operations into separate entities to avoid limitations on taking the deduction.
  • Relabeling employees as independent contractors will be a targeted area of scrutiny.
  • It allows businesses to aggregate the activities of a group of related companies to maximize tax benefits in several ways.

The treasury plans on issuing additional rules and clarifications in the future. The proposed regulations do answer some questions, however there are many areas that continue to remain up for interpretation.

To review the complete text of these proposed regulations, click here.

We will be reviewing the proposed regulations in more detail over the coming weeks.  If you have any questions regarding the proposed regulations, please reach out to DKC for further clarification.

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